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Mock Exam Managerial Economics II

PART A: Multiple Choice
Question 1
According to the IS-LM model an increase in government expenditures
a. Indicates a expansionary monetary policy
b. Indicates a tight monetary policy
c. Shifts both IS and LM to the right
d. None of the above options
Question 2
According to the IS-LM model an expansionary monetary policy shifts the LM curve to the
right as in the picture below

Figure 1 Expansionary Monetary Policy

a. In the new equilibrium because interest rate increases, investment will decrease
b. In the new equilibrium because interest rate decreases, investment will increase but
not consumption
c. In the new equilibrium because interest rate decrease both investment and
consumption will increase
d. None of the above options

Question 3
According to the IS-LM model the IS curve shifts to the right if:
a. there is an increase in current capital stock which leads to higher investments and
hence to higher income
b. There is an anticipated increase in future income so that people feel better off
and experience an income effect
c. There is an increase in taxes
d. None of the above options
Question 4
According to the IS-LM model
a. The overall outcome of an expansionary fiscal policy implies higher income, lower
interest rate, higher investments and higher consumption
b. The overall outcome of an expansionary fiscal policy implies higher income,
higher interest rate, lower investments and higher consumption
c. The overall outcome of an expansionary fiscal policy implies higher income, higher
interest rate, lower investments and lower consumption
d. None of the above options
Question 5
According to the IS-LM model
a. Consumption is a positive function of income and interest rate
b. Investment is a positive function of income and interest rate
c. Consumption is a positive function of income and negative function of interest
rate
d. None of the above options
Question 6
According to the exchange rate definitions is is the domestic currency and $ the foreign
currency:
a. The direct quote can be expressed as /$
b. The direct quote can be expressed as $/
c. The indirect quote can be expressed as /$
d. D none of the above options
Question 7
Consider the case in which today you need 0.23 to buy $1.50 :
a. If yesterday I needed 0.23 to buy $1.58 means that the today depreciated against
the $
b. If yesterday I needed 0.27 to buy $1.50 means that today appreciated with against
the $

c. If yesterday I needed 0.25 to buy $1.50 means that the today depreciated against
the $
d. Options a and b and not option c
Question 8
The spot exchange rate between and $ indicates
a. The exchange rate adjusted by the level of inflation of the two countries
b. The exchange rate of domestic currency per unit of foreign currency adjusted by the
level of the inflation in the two countries
c. The current exchange rate between the two countries
d. None of the above options
Question 9
Given the graph below where is the currency of the domestic country and $ that one of the
foreign country

a. This can indicate the dynamics of a demand and supply model within a fixed
exchange rate regime when the income of the domestic country increases
b. This can indicate the dynamics of the demand and supply model in a fixed exchange
rate regime when the income of the foreign country increases
c. This can indicate the dynamics of the demand and supply model within a floating
rate regime when the the prices of the goods of the foreign country increase
d. None of the above options

Question 10
Given the graph below where is the currency of the domestic country and $ that one of the
foreign country

a. This can indicate the dynamics of a demand and supply model within a fixed
exchange rate regime with an increase in the demand for due to an increase in
the income of the foreign country
b. This can indicate the dynamics of a demand and supply model within a fixed
exchange rate regime when the income of the domestic country increases
c. This can indicate the dynamics of a demand and supply model within a floating
exchange rate regime when the prices of the goods of the domestic country increase
d. None of the above options
Question 11
Given the graph below where is the currency of the domestic country and $ that one of the
foreign country

a. This can indicate the dynamics of a demand and supply model within a fixed
exchange rate regime with an increase in the demand for due to an increase in the
income of the foreign country
b. This can indicate the dynamics of a demand and supply model within a fixed
exchange rate regime when the income of the domestic country increases

c. This can indicate the dynamics of a demand and supply model within a floating
exchange rate regime when the prices of the goods of the domestic country increase
d. None of the above options
Question 12
if P = price of the bundle in domestic currency, P* = price of the bundle in foreign currency,
S = exchange rate in direct quote then the purchasing power parity defines the exchange rate
as
a. S = P P*
b. S = ln(P/P*)
c. S = P/P*
d. None of the above options
Question 13
Consider the following scenario and choose the correct one
a. The submission tutor of the Department of Politics of Birkbeck receives 150
applications from students. Due to asymmetric information the submission tutors will
have to deal with moral hazard problems since he does not know whether the students
will study or not once submitted at the course of politics
b. The convenor of the module International Economics receives the application of
the mitigating circumstances from one of the students that could not make it to
sit the mid-term exam. The convenor in deciding whether or not accepting the
mitigating circumstances is facing a moral hazard problem
c. The teaching panel of the Department of Psychology is selecting the best MSc
dissertation among the dissertations produced by the postgraduate students in the
department of Psychology. The panel in choosing the best dissertation is facing
adverse selection problems
d. None of the above options
Question 14
The Department of Management of Birkbeck is recruiting two posts for admin positions. The
recruiter knows that among the candidates 40% of them are high quality and 60% of them are
low quality. If the recruiter could distinguish the high from the low quality candidates he
would set two different annual salaries: 20k for the low quality and 25k for the high quality.
Because this distinction is not possible the recruiter will set the salary according to the
expected value which is in this case:
a. 22,000
b. 23,500
c. 22,500
d. None of the above options

Question 15
The Department of Management of Birkbeck is recruiting two posts for academic positions.
The recruiter knows that among the candidates 30% of them are high quality and 70% of
them are low quality. If the recruiter could distinguish the high from the low quality
candidates he would set two different annual salaries: 27k for the low quality and 35k for the
high quality. Because this distinction is not possible the recruiter will set the salary according
to the expected value which is in this case:
a. 30,000
b. 29,400
c. 29,000
d. None of the above options
Question 16
Tim has started a company that sells second-hand fridges. In his mind he would be happy to
sell good quality fridges for 115 and bad quality printers for 45. However, as a new entry
in the market Tim is not fully aware about the quality of the products is selling. He believes
that 50% of his fridges are of good quality and 50% are of bad quality. Hence Tim will sell
his fridges at the price of:
a. 70
b. 80
c. 90
d. 75
Question 17
Bernanke and Gertler (1989) find that
a. For a borrower the agency costs are proportionate to his economic wealth
b. For a borrower the agency costs are positively related to his income
c. For a borrower the agency costs are inversely related to his net worth
d. None of the above options
Question 18
Bernanke and Gertler (1989) argue that
a. A fall in the price level makes the borrowers more creditworthy
b. A fall in the price level makes the borrower less creditworthy
c. An increase in the price level increases the agency costs for a borrower
d. None of the above options

Question 19
Credit rationing occurs
a. Because borrowers are not happy to pay high interest rates on loans so they walk
away from the credit market
b. Because borrowers do not trust the lenders due to asymmetric information
c. Because even though some borrowers are happy to pay higher interest rates on
loans, lenders do not have any incentive to increase the interest rate above a
certain level
d. None of the above options
Question 20
According to simulations employed on the basis of the mechanism of the financial
accelerators
a. Expansionary monetary policy do not have any effect on lending-borrowing decisions
b. Firms with relatively poor access to the credit market are more sensitive than
firms with relatively high access to credit market to expansionary monetary
policy shocks
c. Expansionary monetary policy shocks drive firms to delay investments
d. None of the above options

PART B: Exercises and Problems

Question 1
You have 40% of probabilities of getting a salary of 34,000 and 60% of probabilities of
getting a salary of 28,000. What is your expected salary?
Answer:
(0.4x34,000) + (0.6x28,000) = 30,400
Question 2
An estate agent is in charge of the supply of one-bedroom houses in the neighbourhood X.
The state agent is not fully aware about the quality of the houses is managing. What the estate
agent knows is that 25% of the houses are of high quality and 75% are of low quality. If the
estate agent could fully distinguish between low and high quality, he would set a selling price
of the high quality one-bed houses at 230,000 each and a selling price of the low quality
one-bed houses at 185,000 each. Given the imperfect information problem evaluate the
expected market price of the houses
Answer
(0.25x230,000)+(0.75x185,000) = 196,250

Question 3
There are two analysts, analyst A and analyst B. Analyst A says that the GBP will depreciate
against the USD by 0.55p per dollar in the next month. Analyst B says that the GBP will
depreciate against the USD by only 0.33 in the next months. Assuming that both analysts A
and B have equal probabilities of forecasting correctly what would be the expected
depreciation of the GBP against the USD in the next month?
Answer
(0.5x0.55) + (0.5x0.33) = 0.44

Question 4
There are two analysts, analyst A and analyst B. Analyst A says that the GBP will appreciate
against the USD by 0.85p per dollar in the next month. Analyst B says that the GBP will
appreciate against the USD by only 0.23 in the next months. Assuming that both analysts A
and B have equal probabilities of forecasting correctly what would be the expected
appreciation of the GBP against the USD in the next month?
Answer
(0.5x0.85) + (0.5x0.23) = 0.54

Question 5
The Bank of England forecasts a level of inflation equal to 3.5% with a probability of 40%
and 1.2% with a probability of 60%. What is the expected value of inflation rate?
Answer
(0.4x3.5) + (0.6x1.2) = 2.12%
Question 6
The bank Supercredit cannot recognise whether a potential borrower is risk averse or risk
lover. If the bank Supercredit could do it, On the bais of a loan of 100,000 then it would
charge an interest rate of 5.6% to a risk adverse borrower and an interest rate of 6.5% for a
loan to a risk lover borrower. Lets assume that the bank analyst has estimated an expected
return at the point where the interest rate charged is 5.9 for a loan of 100,000. Lets also
assume that the bank estimates that in the market risk adverse and risk lover borrowers are
equally distributed. What would be the expected interest rate charged by the bank for a loan
of 100,000 given that the bank is risk neutral?
Answer
The expected interest rate charged would be of 5.9% since it is the interest rate at which the
bank expects to receive the maximum return from a loan of 100,000

Question 7
The bank Supercredit is specialised in students loans. Supercreidt has only two branches:
one in London and one in Birmingham. Every year they supply about 2,000,000 to
undergraduate students between the two branches. Because they cannot distinguish between
good and bad quality students they tend to incur every year in some loans default. The bank
analyst estimates the loans default in the branch of London and Birmingham. In case of
London the analyst estimates a default of 230,000 out of 1,200,000 with a probability of
80%. The remaining 970,000 have a probability of default of 20%. In the case of Birmingham
the analyst estimates a default of 150,000 out of 800,000 with a probability of 75%. The
probability of default of the remaining 650,000 is of 25%
Compute the expected loss of each branch and then indicate which branch has a highest
expected loss
Answer
London = (0.8x230,000) + (0.2x970,000) = 378,000
Birmingham = (0.75x150,000) + (0.25x650,000) = 275,000
London has a highest expected loss since 378,000 > 275,000

Question 8
The bank Supercredit is specialised in students loans. Supercreidt has only two branches:
one in London and one in Birmingham. Every year they supply about 2,000,000 to
undergraduate students between the two branches. Because they cannot distinguish between
good and bad quality students they tend to incur every year in some loans default. The bank
analyst estimates the loans default in the branch of London and Birmingham. In case of
London the analyst estimates a default of 400,000 out of 1,200,000 with a probability of
80%. The remaining 800,000 have a probability of default of 20%. In the case of Birmingham
the analyst estimates a default of 200,000 out of 800,000 with a probability of 90%. The
probability of default of the remaining 600,000 is of 10%
Compute the expected loss of each branch and then indicate which branch has a highest
expected loss
Answer
London = (0.8x400,000) + (0.2x800,000) = 480,000
Birmingham = (0.9x200,000) + (0.1x600,000) = 240,000
Still London

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Question 9
The bank Supercredit is specialised in students loans. Supercreidt has only two branches:
one in London and one in Birmingham. Every year they supply about 2,000,000 to
undergraduate students between the two branches. Because they cannot distinguish between
good and bad quality students they tend to incur every year in some loans default. The bank
analyst estimates the loans default in the branch of London and Birmingham. In case of
London the analyst estimates a default of 200,000 out of 1,200,000 with a probability of
90%. The remaining 1,000,000 have a probability of default of 10%. In the case of
Birmingham the analyst estimates a default of 250,000 out of 800,000 with a probability of
70%. The probability of default of the remaining 550,000 is of 30%
Compute the expected loss of each branch and then indicate which branch has a highest
expected loss
Answer
London = (0.9x200,000) + (0.1x1,000,000) = 280,000
Birmingham = (0.7x250,000) + (0.3x550,000) = 340,000
Birmingham has the highest expected default since 340,000 > 280,000

Question 10
In the last 2 years in Goldland the price level of the price level of the houses has been
increasing at a constant annual rate of 2%. Due to an economic instability dynamics analysts
are not very confident in the fact that this trend will continue for the next year. They estimate
that next year the price level of the houses will keep this trend with a probability of 25%.
While they estimate that price level of the houses will decrease next year with a probability of
75%. On the basis of the notes on the credit channel and the financial accelerator mechanism
would you say that on the basis of the analysts forecasting the agency costs of the potential
borrowers will decrease next year? Argue your answer
Answer
Bernanke and Gertler (1989) find a negative correlation between borrowers net worth and
agency costs. A reduction in the price level makes individual less creditworthy since it
reduces the value of their assets and it reduces their net worth. Due to the expected
probability that the housing market price will reduce and given the inverse relationship
between net worth and agency costs, the agency costs of the potential borrowers are expected
to increase.